Paying Off Debt: 6 Steps to Building a Better Snowball

The “snowball method” for paying off debt isn’t something out of the movie Clerks. It is a way to organize your outstanding debt in such a way that the funds you have available for paying off debt are optimally distributed in the manner that will allow you to pay off that debt quickly and cheaply.

There are two opposing philosophies or approaches to the snowball method. The first system was popularized by financial guru Dave Ramsey. In his own words, here is his approach to the Debt Snowball method:

List your debts in order with the smallest payoff or balance first. Do not be concerned with interest rates or terms unless two debts have similar payoffs, then list the higher interest rate debt first. Paying the little debts off first gives you quick feedback, and you are more likely to stay with the plan.

Once you have your debts listed in order, pay the minimum payment required to all the debts except for the debt on top, which should receive all the remaining funds for debt service. The value of this approach is in the small victory. By paying your debts off from smallest balance to highest, you will reach satisfaction quickly. For someone who has made debt their way of life, has made the commitment to turn over a new leaf, and requires small successes for motivation, this approach may be beneficial.

Debtor beware: If you choose the above method, you could be paying more interest than necessary for a longer time period than necessary. Simple financial calculations show that if you order your debts from highest interest rate to lowest interest rate rather than lowest balance to highest balance, and then follow the same steps outlined above, you will pay off the debt sooner and spend less on interest throughout.

The big assumption is that you will be able to focus on the larger goal of paying off the entire debt without a quick rate of successes to constantly motivate you. The higher interest rate method still sees you paying off smaller debts throughout the process, so it’s not completely without motivational cues.

Let’s assume I have three credit cards to pay off. Remember the rates stated are hypothetical for the purpose of illustration the first is a Slate from Chase Card with a $13,000 balance and an interest rate of 14.99%. The second card is an airline travel card with a $9,000 balance and an interest rate of 13%. The final card is a United MileagePlus Explorer Card with a balance of $7,000 and and APR of 7%.

Remember, this is a hypothetical example and not my personal debt situation. Here’s how to use my improved snowball, Flexo’s Debt Avalanche.

Like Dave Ramsey says, the first step is to establish an emergency fund. That’s important, but not directly related to paying off the debt, so let’s use that as our initial starting point and call it Step 0:

Debt Avalanche Step 0. Establish an emergency fund. For someone who is working on paying off debt, the optimal emergency fund should be all cash, deposited in a savings account. Savvy financial all-stars have other options available to them (like a Roth IRA or — as a matter of fact — credit) but for someone on the road to recovery, cash is the best option. Consider leaving a portion of your cash in a local bank or credit union for fast access but the bulk of the deposit should be in a high-yield savings account such as Ally Bank or ING Direct.

It’s good to build up several months’ worth of expenses in this fund, but once you get a foundation of $1,000 or so, don’t hesitate starting the Avalanche.

Debt Avalanche Step 1. Commit to avoiding new debt. You should not add to your credit card balances while in Avalanche mode. It would be massively counterproductive. Also, while you are paying off debt, you will be forced to live within your means. Once your debt is fully paid off, continue living below your means with cash.

If you have truly changed your approach to using credit during this time, you may safely be able to use your credit cards again to take advantage of convenience, rebates, and other special offers. But let’s not get ahead of ourselves. The goal is to eliminate credit card debt as well as the need for credit card debt. From now on, you will only spend less than you earn, only in cash.

For some people this is a major change in philosophy, or a “paradigm shift” as motivational speakers are wont to spew. Whatever you call it — eureka, an epiphany, common sense, or Enlightenment — you have to be in the right mindset before you can be successful. For those set in their ways, this will be the most difficult step, but it must be completed before moving on to Step 2.

Debt Avalanche Step 2. Call your creditors and negotiate lower interest rates. Your credit card companies will be happy to reduce your interest rate, but in some cases, they will close your card and not allow you to make further purchases. That’s fine! You are in Avalanche mode and you have no need to use the cards again for purchases. Our example debtor was able to lower his Business Gold Rewards Card interest rate from 14.99% to 9%.

Even if you think your interest rates are already “low,” call your customer service representatives anyway. Keep going up the ranks of supervisors until someone lowers your interest rate.

Step 2a. Some time — maybe a month or two — after you negotiate, check your credit reports for free via CreditKarma.com. Verify that your credit cards didn’t provide the agencies with information that could potentially be harmful to your credit score. If a card is listed as closed, it should be listed as, “Closed at account holder’s request” or with similar terminology, not, “Closed at issuer’s request.” Dispute any incorrect information with the reporting bureaus as necessary.

Look also at the minimum payment required by each card. You should have enough cash available from income each month to meet all of your minimum payments plus some. If not, then you may have to negotiate more than just interest rates. The solution may be to consolidate your debt into one credit card, a bank loan, or a home equity line of credit. This may stretch out the time it takes to finish paying off the debt, but it is the best way to meet your monthly obligation.

Step 2b. Take a pair of scissors and slice your cards into small pieces. For those seeking an emotional high to boost and motivate them through the process, like the small victories Dave Ramsey says are important, this may provide the same feeling and effect. Listen to Pink Floyd’s song “One of These Days I’m Going to Cut You Into Little Pieces,” which may have been written about the process of paying off debt despite the band’s claim otherwise.

Debt Avalanche Step 3. Use this calculator (with the “Interest Order” option) to determine the amount to send each card each month, and stick to this schedule without missing one payment. For fun compare the “Interest Order” option to the “Balance Order” option. With the example debt, a total of $1,000 available each month, and minimum payments of 2% of the balance on each card, the “Balance Order” option as prescribed by Dave Ramsey would cost about $500 more and take one month longer than the “Interest Order” option. That’s a shame; perhaps you could have spent that $500 on Dave Ramsey’s seminars and books. But you won’t, now that you see his plan is mathematically inefficient.

Better yet, if you want to part with an unnecessary $500, just send it to old Pink, care of the Funny Farm, Chalfont.

Debt Avalanche Step 4. Automate your payments so you don’t even have to think about them. Reduce stress, reduce agony, and increase your time on other life-enriching activities. Have your credit card deduct the appropriate amount each month directly from the checking account is directly deposited. This may be difficult if your amount changes each month, but at the very least, set up direct debit so all you have to do is click a few buttons online rather than writing a check.

When the first card is completely paid off, shift the largest amount of available cash to the second highest-balance card, still paying the minimums on the remaining debt. Lather, rinse, lather, rinse, ad finitum, or until pigs (three different ones) fly.

Debt Avalanche Step 5. Get in the groove of spending within your means by cutting back expenses. Perhaps you can think about creating a budget if your means are tight. If you want to spend more, find ways to earn more. If you haven’t already, formalize your personal finances. Grab software like Quicken or sign up or Mint and track all of your expenses, including what you spend with cash every day, and map out a formal budget.

Want support from a community of individuals in a similar situation? Start an anonymous personal finance blog and write about your journey, complete with struggles, triumphs, and more than enough melodrama to go around. (Just don’t beg people to send you money to help pay off the debt you incurred. That’s not classy.) Also check out No Credit Needed, the premier blog for eliminating debt.

Debt Avalanche Step 6. Complete your payoff and celebrate. How you choose to celebrate is up to you, but it would be a good idea to reward yourself without getting back into the credit card habit.

Taking advantage of airline miles rewards and cash back rebates is an advanced technique better undertaken by someone who has shown they can use credit responsibly and avoid late fees and interest payments while paying off their entire statement balance each month.

After you have reformed your spending ways, you may be ready to make money off of credit cards with 0% APR deals or balance transfer arbitrage, which take some discipline, perserverence, and willingness to fight to get what you want from unscrupulous credit card companies.

Harrison: Exactly. If one doesn’t become a person who lives within one’s means — and it is possible to change with dedication, drive, desire, and support — one could still go through all the steps but eventually end up at the beginning, burdened by credit card debt.

I have a card that I was approved for with 0% APR on balance transfers AND PURCHASES for 12 months. I did not get in on the initial balance transfer offer, so there is a 3% charge on future balance tranfers. I use it for purchases and deposit my entire paycheck into my bank account, rather than taking out $250 every other week. I pay for groceries with this card as well rather than writing a check. That is money I can use to pay down high interest cards. Funny that I don’t see any advice out there about using available credit limit to perpetuate balance transfers onto lower APR cards while paying off high interest rate cards. There is a substantial amount of hidden money that can accellerate the debt reduction process.

Great advice. I still don’t get the initial emergency fund idea though. That $1000 in savings is not helping me when I have thousands of $$$ at 18%+. How much quicker would I get my stuff paid off if I used that $1000 to pay credit cards, etc. off? THEN build the emergency fund. It will take a lot less time, and I still have the cards if something goes wrong before the zero debt point…

We all need to do our best to limit our spending and frivolous purchases. I might recommend stealing your neighbor’s wireless signal for internet, canceling cable,service and downloading free stuff from the internets, getting a pre-paid cell phone nand skype (skype is $3 a month for unlimited calls to any phone in the world), and cycling when and wherever possible. To most Americans these ideas will sound absurd, too difficult, or illegal. But it’ll lower your expenses, cut your carbon footprint, and give you more beer money.

The theory behind the emergency fund, I think, is that if you don’t have one, the unexpected costs that occur (a/c going out, car repairs, etc) will have to come out of your debt snowball or avalanche money, and you will have a harder time paying off debt. Once you have an emergency fund, you are no longer using credit for that, which also helps with not adding to the amount of debt on your credit cards.

I am following the Dave Ramsey plan of debt snowball. I can tell you him plan is for me the best way, and to the comment that it is mathematically inefficient. Dave would say that if we could do math, we wouldn’t be in debt.

Mahonjh: That’s great that Dave Ramsey has helped you get inspired to get out of debt. He’s wrong about the math comment, though. Even the best mathematicians can get into debt, but that doesn’t mean that they or anyone with lesser math skills can’t handle a better system of getting out of debt. If you’re willing to pay more (in larger interest payments using Dave’s system) and take longer to get out of debt, then you’re not really improving your money management skills. You’ll get there, and that’s better than nothing, but you could have chosen a cheaper and faster path.

One note, about which method to use. If you have financial discipline, I’d go w/ highest rate first. If, on the other hand, you really need to SEE some quick results, to stay motivated, I’d go w/ lowest balance first. In fact, I’d say that SEEING that first small balance disappear, for me, was worth 1000 bucks in extra motivation… Or, combine the two, paying off a few small balances to begin w/, and the rearranging the plan, based on rates, once you get the hang of it.

Wow, I just stumbled across this page and will be trying out this method. I have a large student line of credit, one large sum in collections (13k) and 2 other credits cards that arent as large but close to it.. I have a decent job now, but stuggled the entire time I was in school. I am now paying for my misguided ways.

I already have a saving account that I was use to save for a down payment on a house..I usually dont touch it. I put 11% of my monthly income there.

I have a $500 credit card that is at a zero balance, can that not be my emergency fund?

So far I have been paying large sums to all of my debit and have so far only paid off one small credit card debt. I am hoping this method will pay off my debts fast.

Just a question about my collections. Its at no interest now but its very bad for my credit score. I read it will stay on my credit report for 6 years after the day I paid it off. Currently I am paying $400 a month on this debit. Should I still keep this debt last on my list?
I just want to try and repair my credit score AND pay off my debit.

Two things to offer. Smallest debts first is the way I recommend to most people. Most people aren’t in control and rational with their finances and the ability to see results is the thing that really starts to cement the behavior change. They start to taste freedom and want more. As I dug out from 70k in debt, I did Ramsey’s method until I had enough knowledge and passion to switch stick out the slog through my highest interest debts. Proper math isn’t worth anything if you derail half way through paying off a large highest interest debt first because you get distracted or lose the passion.

Second, I have a graphical debt snowball calculator that I created that is meant to be visual based and easier to compare different payoff strategies and the effects of extra payments. It is a bit rough, but I am willing to make any changes/updates to it that will help empower people to get out of debt faster.

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About Luke Landes

Luke Landes founded Consumerism Commentary in 2003 and has been building online communities since 1990. Luke has contributed to PC World Magazine, US News, Forbes, and other publications. Read more about Luke and about Consumerism Commentary.

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